Essays on Inequality and Fiscal Policy

This PhD thesis gathers three essays on income inequality and fiscal policy. Chapter 2, “Inequality and the Size of Government”, written with Andrew Pickering and Paulo Santos Monteiro, revisits Meltzer and Richard (1981) but with the twist that income inequality is induced by differences in capital income as well as differences in labor productivity. When capital income is difficult to tax, as often observed, then greater capital income inequality leads to reduced demands for tax as the poor cannot effectuate redistribution. Using OECD data, government size and capital income inequality (proxied by the top 1 percent income share) are found to be negatively related in both fixed effects and instrumental variable regressions. Chapter 3, “Inequality and Growth in the Twenty-First Century”, builds on chapter 2 to investigate how economic growth is affected by inequality in an endogenous growth model. The benchmark is Persson and Tabellini (1994), who argue that productivity-induced income inequality leads to lower growth as distortionary taxes increase and harm capital accumulation. However, if income inequality stems from differences in capital, then labor tax rates fall, leading to higher growth. Based on OECD data, the chapter shows that an increase in capital income inequality has a significant positive relationship with subsequent economic growth. Chapter 4, “Demography and the Composition of Taxes”, analyzes the impact of population aging on the composition of taxes in an overlapping generations model. When the median voter is of working age, then population aging increases the demand for expenditure taxes rather than income taxes in order to increase the tax burden on the retired population. Consistent with the theory, international panel data exhibit a robust negative correlation between the extent of taxes on income relative to expenditure, and the fraction of the retired population.